Large Inc is a conglomerate planning entering into a new industry.

There is currently one firm in this new industry, MinInc.

 

MinInc has a debt equity ratio of 1/3. The EBIT of MinInc is expected to be $80m even year and lasts forever. MinInc's total value (debt and equity) is $200m.

 

Both LargeInc and MinInc can borrow at the riskfree rate of 10%. The corporate tax rate for both firms is 50%.

- What is the cost of equity of MinInc?

- Suppose LargeInc is planning to make $100m of initial investment for the new business and expects to earn $40m of EBIT every year forever. Assume the depreciation is equal to 0. If the initial investment is fully financed with equity only, what is the NPV of the project?

- Instead of fully financing with equity, LargeInc decides to borrow $100m non-amortizing loan at 10% interest rate for 5 years. What is the NPV of the project?

Answer rating: 100% (QA)

ANwer 1 Cost of Equity of MinInc Given the debt equity ratio of 13 and total value of MinInc is 200 ... View the full answer